Questions and Issues on Clients' Minds

In the wake of the new changes to the Fair Labor Standards Act, many employers and HR professionals may take comfort in the fact that the federal regulations on employee paid time off have not changed. In fact, those regulations will continue to not exist. America is one of the few developed nations that does not have a federally mandated vacation policy. According to the 2016 Employee Benefits report by the Society for Human Resource Management, 97% of US companies still choose to offer some form of paid leave. Whether it’s a traditional vacation policy that accounts for vacation, sick leave, and personal time separately, an all-inclusive paid time off (PTO) policy that combines various uses of time into one pool, or new (and fairly uncommon) unlimited PTO policies; American workers are being given a hall pass to leave our desks.

The American workforce however appears conflicted over the idea of not working. On the one hand we expect vacation time from our employers and scrutinize vacation and paid time off benefits when considering job opportunities. Then, on the other hand, we horde our accrued vacation time and stay affixed to our desks year in, year out. American workers are among the worst employees in the world at taking vacation time. Several studies have indicated that more than half of American workers do not use all of their vacation time each year. Other studies suggest that of those workers who did take a vacation about half of them continued to work while on vacation.

The benefits of un-plugging and getting out of the office have been covered in countless studies on workforce engagement, productivity, retention, employee health, and general job satisfaction. The drawbacks of employees’ not taking time away from work have also been extensively covered and include fatigue, burnout, turnover, transmission of illness, and reduced productivity.

So why aren’t people punching out? Reported explanations for not taking vacation include increased work load, fear for job security, and financial concerns. In this post-recession era we find many employees may have changed jobs at least once, changed industries, have less tenure than they expected at this point in their career, or are still picking up the slack generated by a do-more-with-less survival downsizing that took place. All of these issues threaten the use of vacation time as employees fear a backlog of work, believe they are the only one who can fill their role, or want to show commitment and determination to their supervisors.

Fortunately, technology and connectivity have made getting away from our desk possible. Many companies encourage the use of flexible schedules and work spaces to help employees maintain a comfortable work/life balance. It’s no longer only small business start-ups that have employees working from coffee shops and home offices. The downside however, is that getting away from our work is becoming increasingly difficult. The message has become “Go home, but keep working”. One study suggests that more than half of employees in the U.S. do not have an open dialogue with their supervisors regarding the use of vacation time and truly disconnecting from work.

Thoughtful administration and effective communication of current paid leave policies may get us closer to a well-rested, healthy, vacationed workforce. But it may also be time to revisit the policies themselves to ensure you have the right paid leave structure for your organization. If PTO plans aren’t being used correctly for instances of illness (ie. paid-time-off being horded for vacation instead of used for sick leave) perhaps a traditional vacation and sick leave policy will encourage the use of time off when needed. Other possible policy changes may include mandatory time off, reduced roll-over accrual for unused time off, or reduced payouts for unused time off.

The overwhelming trend is that Americans are not taking enough time away from their jobs for equally important matters of rest, relaxation, healing, and wellbeing. Disconnecting from our work lives takes intentionality and commitment on behalf of the employee as well as the support and encouragement of the employers. Management must encourage, if not enforce, well designed time off policies.

The Wells Fargo incentive pay problem is at least as old as Matthews, Young; and we’ve been advising the banking industry on performance-based incentive compensation for over 40 years. Decades ago when we discussed design of incentive plans, we would half-joke about avoiding the creation of an employee mindset of “open an account and get a new toaster; open three new accounts and get three toasters”.

Our experience tells us that a cardinal rule of incentives is that you get what you pay for – in terms of employee behavior and results. If your bank sets new account goals without incorporating a balancing measure like branch customer satisfaction, you are sending a problematic message: account growth matters and gets rewarded and customer satisfaction does not. If your incentives are driven by Net Income growth without corresponding Return on Assets / Equity measures, you are telling management that it’s okay to inflate the balance sheet for that extra dollar of profits. If loan growth is the key to incentive earnings without corresponding credit quality requirements . . . well, we all know where that got us in the recent past!

Business news reports of the Wells Fargo problem indicate that another cardinal rule of incentives may have been violated: employees must have a reasonable chance of achieving goals and not fear losing their jobs for failing to achieve what they perceive as unobtainable results. Such a situation will cause some employees to quit trying and others to start their search for different employment. Or in the Wells Fargo case, employees will find a way to achieve goals even when they know their behavior is inconsistent with customer interests and, ultimately, shareholder return.

We also believe that Wells Fargo’s decision to cancel incentive plans is an over-reaction. Well-designed incentive plans are an effective management tool to:

focus attention and action plans on key results

motivate individual effort and teamwork

link company and employee success

The Wells Fargo story will fade in the press, but we believe it should be a wakeup call for banks to take a fresh look at incentive plans. With the new year approaching, now is the time to ask the tough questions: Are performance measures balanced with respect to growth, profitability, soundness, and customer satisfaction? Are expectations reasonably obtainable and do employees have the proper tools and training to perform at their best? Are payout levels competitive but reasonable compared to base pay (e.g., are high incentives necessary for cash compensation to be competitive)? Are we supporting our incentives plans with effective employee communications that explain expectations for results and behavior?

Matthews, Younghas been advising banks, thrifts, and credit unions for over four decades on the use of sound incentive compensation. We are experienced in the design of new plans as well as the review of existing plans. Contact us at: Info@MatthewsYoung.com.

Executive compensation and performance-based pay continue to be a hot topics in board rooms and in the press. Corporate directors should be wary of compensation plans that can distort the pay for performance equation. Two pending SEC rule changes may impact how public companies implement executive compensation in the future: the Pay for Performance disclosure, and the CEO pay ratio. Where CEO pay and company performance are misaligned, proxy reporting will raise a red flag for shareholders and investor groups. Large pay packages that result in problematic CEO pay ratios (the ratio of CEO pay to employee median pay) have been key topics in the press as companies anticipate the implementation of the SEC’s new pay ratios rules.

As the deadline nears for implementing these new pay disclosure rules, public boards and executives should focus on the effectiveness of all elements of executive pay. Since a large part of CEO compensation is long-term incentives, typically stock-based or plan-based compensation, these plans should be closely evaluated. While public companies will be concerned with the new pay rules, private companies will also be interested since pay for performance is a best practice. Consequently, long-term incentive pay will be a focus in the near term.

Historically, long-term incentives were granted to retain executive talent; executive retention is greatly enhanced when adding a vesting feature and a forfeiture clause for executives who leaves before vesting. Retention in the form of long-term incentives generally were implemented using stock grants, primarily in the form of restricted stock and RSUs with vesting after three or five year’s continuous service. Stock options could also be used to help with retention; however they often lose their effectiveness when the stock price drops and options fall underwater. While these types of grants are effective retention tools, they lack the focus that is generated with performance-based incentives.

We believe that a meaningful way to measure the effectiveness of long-term incentive compensation is to evaluate whether the incentives reward senior executives for meeting and sustaining the strategic goals of the company. While service vested stock grants have an element of performance, too often vesting of large stock grants occur during a time when the company’s performance is declining. This misalignment of pay and performance can send a bad message to shareholders and regulators. A better message to send occurs when a large block of stock vests when the company achieves a key success or during a period of excellent performance. For this reason, we believe that long-term incentive pay should be primarily tied to company performance that is linked to long-term, sustained improvement in shareholder value.

Naturally, these incentives should be linked to the executive team’s success against the main goals outlined in the company’s strategic plan. This can be a complicated task. Executive teams are leery of setting performance expectations too far into the future due to the uncertainty of the business environment. The need to set goals that are measurable and meaningful is a significant factor in a plan’s success. A few key goals can be far more meaningful than a long list of performance objectives that may be difficult to track and fraught with confusion about final outcomes. Ultimately long-term incentive plans should (1) be simple enough to communicate to multiple constituencies, (2) reflect the expectations of the board over a long time period and (3) align with sustained and improved total shareholder value.

However, long-term incentives tied to key performance objectives often compete against the desire to meet annual incentive plan goals. Focus on short-term earnings performance and near-term outcomes to satisfy investor groups can be a detriment to achieving a long-term strategy. For public companies, too much emphasis is placed on quarterly results at the expense of meeting longer term objectives. Private companies have less pressure, but the tension between short-term performance and longer term strategic objectives still exists. Successfully implementing performance-based long-term incentive plans is one way to counter the pressure of shorter term thinking.

For example, most financial institutions are experiencing pressure to boost their earnings because of declining revenues due to low interest rates. Could this lead bank executives to seek higher interest rate loans with greater risks or higher market concentration in order to generate higher rates and more fees? Could this pressure to boost earnings cause executives to drift away from the long-term strategy of the bank? Of course it could; this is reasonable outcome when pressure on short-term earnings overshadows the long-term strategy of a bank; this focus could be a problem for future success. Our suggestion to counter this short-term behavior is to establish long-term incentives linked to an emphasis on loan portfolios that are more consistent with the bank’s strategic direction.

So what are some of the key issues to address if you want to implement a performance-based long-term incentive plan? As a first step, do you have an up-to-date and effective strategic plan? If not, start here. Next, you need to decide whether stock or cash is the best way to provide executive incentives. Also, determining the best time frame for vesting is another important step. We think a minimum of three to five years makes sense. However, you may want to tie the vesting to a major business initiative or a future liquidity event; these events don’t always occur on a fixed schedule. Using multiple grants (annual or biennial) can add another favorable dimension to the plan design. Having rolling vesting dates can help sustain the plan’s long-term momentum. These plan design features and many other plan design decisions must be made when implementing a new plan or moving the emphasis away from service vesting toward performance vesting.

In summary, performance-based long-term incentive plans are a recognized best practice among industry experts and corporate governance groups like ISS and Glass Lewis. With the SEC implementing new rules that will spotlight pay for performance and CEO pay, this may be an excellent time to evaluate your current executive compensation plans to make sure that executive pay is closely aligned with company performance. Finally, directors and executives should examine both the annual bonus plan and the long-term incentive plan to validate that these plans are fulfilling the long-term strategic needs of the company.

The pace of progress is quickening as we begin this, our second in the series of our history of banking as if it occurred in one week. But, it isn’t until 7:26 on Wednesday morning that the story of American banking starts to unfold. The actual date is 1741 and the problem is tight British control over the number of coins entering the Colonies. Americans are tired of relying on crop notes and barter, and decide to start banks of their own. The predictable response is a legal roadblock. The British prohibit banking and the experience sours many American Colonists on financial institutions.

This Wednesday of our banking week closes with a very significant American event, the end of the Revolutionary War. It is 14 minutes after midnight on Thursday before Alexander Hamilton establishes a federally chartered Bank of the United States over Thomas Jefferson’s strong objections. Yet the charter of the bank runs just 20 years and by Thursday evening it is dead.

In fact, when the U.S. Government needs to borrow $11 million to buy Louisiana – in our time sequence this 1803 event takes place at 9:29 on Thursday morning – no U.S. bank has enough clout to finance the deal. Fortunately, a British institution steps up to the plate. For America, Thursday turns into a very long night filled with the nightmare of the Civil War. Yet as Friday dawns, the United States enters a promising new day. The country is unified and state banks are flourishing. Though state banks in the South had weakened or disappeared, a rebirth has begun.

It is mid-day on Friday – 11:31 a.m. – when the National Bank Act of 1863 passes. The leaders on this Friday are men of integrity like Israel Lash, who launches the First National Bank of Salem (N.C.) to serve thrift-conscious Moravians, after it becomes clear that The Bank of Cape Fear’s Salem branch (Lash’s former employer) will not be part of the revival. Late this Friday morning, Alfred Austell founds one of the oldest banks in Georgia in his home. Though the Reconstruction Act absolved Austell from any obligation to redeem his former bank’s Confederate money, Austell depleted his personal fortune to exchange this money for gold, an act of faith his former customers clearly remember. As the National Bank Act strengthens federal control over banking and currency, Austell, Lash and fellow bankers are encouraged to make new beginnings.

Over the lunch hour that Friday, it appears American banking has finally gained a stability that has been very elusive during its first two days of life. At long last the nation has a uniform currency, gained primarily by taxing state-chartered bank’s notes, rendering them of insignificant value.

On Friday – the fifth day in our banking week – the nation is charged with great creative energy. Before Friday ends, Thomas Edison produces the first commercially viable electrical lamp and George Eastman markets his first box camera. Yet as Friday – and the first five days of modern banking history – draw to a close, surprisingly little has changed in the way banks operate. The Monday morning customers of Amsterdam Wisselbank would feel comfortable in the Friday evening banks of the United States.

However, there are blips on the radar screen that predict a storm of activity. For example, when transatlantic cable is laid in the 1870s – 3:43 p.m. Friday in our time line – some bankers realize they can take advantage of small price differences in New York and London markets to profit on arbitrage. This begins a much more creative time and one that evidences strategic innovations that will ignite a tremendous leap forward in the pace of change, yet one that also will elevate that risks and develop new challenges for the industry.

A few years ago, a well known and well respected bank CEO observed that in today’s world three years of change seem to be compacted into every six months of banking history. I hardly ever disagreed with him, but in this case I believe that his compression idea is on target but a little too conservative.

After meditating on the observation, I thought it might be interesting to try to condense the history of modern banking into a single week—a mere seven days. While daunting, I think it will depict just how much has happened in a relatively short span of time. For the next few months, follow along with me as we review the 7 short days of the week and the evolution and the rapidity of that change. In this context, banking as we know it has developed within the last hour. And, in the next few minutes, banking is almost certain to be changed beyond recognition by profound technological, economic, political and cultural changes buffeting our business. Today, it is not change, but the pace of change that is unique and creates banking challenges of a new magnitude. Creative strategy becomes a necessity, but difficult to tackle.

So, to depict how history’s pace has quickened, try to measure banking events in terms of one ordinary Monday-through-Sunday week. The first day of this week – a Monday – marks the arrival of modern banking, while the latter part of Sunday represents 2009, the 400th anniversary of modern banking. We will have just gone to bed when the first four years of the next century begins – and what a beginning! For this exercise, the first minute of Monday – 12:01 a.m. – is the year 1609. It is when the Amsterdam Wisselbank opens its doors – an excellent beginning for our modern era.

Of course, many aspects of banking predate 1609 and set the stage for our four century banking week. But the banking week we have defined is more than adequate to demonstrate the accelerating pace of change. On the Monday modern banking arrived, Shakespeare was busy writing sonnets, trade was flourishing and the merchant class was on the rise. The Amsterdam Wisselbank opens with a broad charter – to accept deposits and bills of exchange, transfer payments among customer accounts, mint coins and lend money. This institution thrives for 200 years – about 4 days in our compressed time capsule.

Throughout the wee hours of Monday morning, growing numbers of English goldsmiths who safeguard customer deposits discover that owners never demand more than a fraction of their reserves in payment. So they gain more and more confidence about using promissory notes to lend on deposits. These goldsmiths’ paper certificates serve as currency, increase the money in circulation and fuel economic expansion. One might say that their strategic vision was to enable customers to build businesses through providing credit and thereby enhancing profitability. It is now a short step to a bank check. The first check is written at about 9:00 Monday night. This 1659 check evolves from the practices of British institutions that specialize in mortgages and legal services. Adding additional products and services has already begun.

By the end of the century –2:13 p.m. Tuesday, London has become a major financial center and the Bank of England has begun to serve as a role model for central banks. Next time we will see what Tuesday evening and part of the rest of the week brings as the pace of progress is beginning to quicken.

Finding the time and resources for board and committee development is an ongoing challenge. But enhancing the effectiveness of your Compensation Committee can be done with a few key actions. This blog and ones that follow will address:

Setting a workable Committee calendar

Selecting membership

Continuing education on executive compensation

The beginning of the year is a great time to update or set up a calendar for your Compensation Committee. Committee responsibilities and activities need to

be spelled out in advance and scheduled throughout the year to:

Balance the Committee’s workload

Allow sufficient time for review before decisions are required

Ensure that decisions are well-timed for effectiveness as well as meeting any regulatory requirements

The first step in building the calendar is listing and grouping activities. You may be surprised at how many issues need to be addressed when you write them all down. Our basic categorized list includes:

Compensation Philosophy Statement

This roadmap for guiding Committee decisions should be reviewed at least annually.

If you don’t have one, you would be surprised how helpful having written principles can be.

Market and Peer Group Review

Update the peer group for relevancy.

Gather compensation data from surveys and proxies.

Monitor performance versus peers.

Performance and Salary Review

Board/Committee review of CEO performance; and CEO review and report on other senior officers.

Committee review of CEO salary and adjust based on market/peer pay levels and executive job performance.

Conduct at least annually – ideally just after the end of the year so the Committee can look back at the prior year and plan for the year just beginning.

Director Compensation

Determine frequency of review (we recommend an annual review; but at least every third year as a minimum).

Conduct review and recommend changes to Board.

Of course, companies participating in government programs like TARP or those who are required to report to the SEC have a number of other requirements and activities that we won’t try to cover here. Suffice it to say that these requirements are a significant expansion of the previous list.

Filling out the calendar is best done using a grid with the major categories of work down the left side of the calendar, and the months across the top. This approach allows you to schedule the items in each category in logical order as well as look at the volume of Committee work in each month.

Finally, this is a task best completed by the Committee Chair, CEO, and outside compensation consultant if you have one. You may also want your CFO and Chief Human Resources Officer involved if they interact directly with the Committee.

In a previous blog entry, I talked about improving Executive Compensation Committee Effectiveness by setting up an annual Committee calendar to balance workload, set priorities, and ensure timely and effective decisions.

This follow-on blog highlights four important elements for effectiveness from the standpoint of Committee membership, structure, and decision-making authority:

Characteristics of effective committee members

Appropriate committee size and turnover

Balancing other committee assignments

Assigning sufficient authority

Characteristics of Effective Committee Members

Some Director backgrounds are more appropriate than others for the Compensation Committee. Candidates with formal corporate management experience or service as professional directors tend to have a better perspective for dealing with complex compensation issues. Directors with entrepreneurial or smaller company experience may not have faced these kinds of issues before.

Appropriate Committee Size and Turnover

Our experience shows that the Compensation Committee needs at least three independent members but typically not more than five. Decision-making is streamlined with a smaller committee; but don’t get so small that you limit important interaction and having a range of perspectives that ultimately builds strong consensus. Also, you should change no more than one-third of the committee’s members in a year. Otherwise, you lose “institutional memory” and valuable experience and expertise that takes a while to develop.

Balancing Other Committee Assignments

Because of the importance placed on the governance of executive compensation, membership on the Compensation Committee should be a director’s primary committee assignment. If at all possible, don’t place directors on both the Compensation and Audit Committees. While you want your best directors on your most critical committees, you don’t want to stretch them too thin.

Assigning Sufficient Authority

And finally, all Boards of Directors should take the time to determine what level of authority the Compensation Committee will hold. We believe that Compensation Committees are most effective when the Board assigns them specific decision-making authority. Where full Board voting is desired or required, the Committee should always bring a specific recommendation that the Committee has developed and fully supports.

If you would like a sample Compensation Committee Membership Profile, we would be happy to send you one. Click on the button below to request a copy.